Are you an unwitting tax evader? I only ask because quite a few investors seem unaware that fund accumulation units attract income tax on dividends just as much their more transparent ‘income unit’ cousins.
Accumulation units are a class of share that automatically reinvests dividends1 straight back into your Unit Trust or OEIC fund. In contrast, income units cough up dividends directly, paying you cash like three cherries on a fruit machine.
But not physically taking delivery of your dividends is no protection from HMRC. The taxman still wants his cut. Dividends rolled up into your accumulation units are known as a ‘notional distribution’ and are taxable in exactly the same way as income units.
In other words, you owe income tax on dividend income unless:
- You’re a basic rate taxpayer/non-taxpayer – in this case the notional tax credit attached to dividends takes care of any liability you have.
- Your funds are held within an ISA or SIPP and are therefore off the taxman’s radar.
The taxman cometh
Higher and highest rate taxpayers are thus on the hook for income tax due on any accumulation unit dividends that are snowballing outside of tax shelters.
The dividends are reinvested net of basic rate tax, which means that higher/highest rate taxpayers will actually have to find extra cash to pay their dues, as all the divi cash is sucked up into the fund.
Worse still, some investors are no doubt paying tax twice when it comes to their capital gains tax bill!
You don’t have to pay capital gains tax on the dividends that have fattened your fund. So when you come to fathom the capital gains on your accumulation units (and as your resultant psychic scream reverberates around the universe), make sure you deduct any reinvested income from the total gain, otherwise you’ll be overpaying.
Of course, you can only make those deductions if you’ve been meticulously recording the dividend distributions that dropped in to your accumulation funds over the years.
And who doesn’t do that…?
The problem is accumulation unit distributions are more stealthy than income unit payouts, as you don’t get to do a little dance every time those divis turn up in your trading account.
So where can you find out about them?
- In your broker’s statement, if you’re very lucky.
- Trustnet keeps a good account of accumulation unit distributions – find your fund then click the dividends tab.
- In your fund’s annual report.
Worth the hassle?
The main advantage of accumulation units is to skip the cost of reinvesting dividends. But this cost saving is rendered superfluous if your fund isn’t saddled with trading fees or initial charges in the first place. Many tracker funds fall into this bracket.
Others prefer to hold income units outside of a tax shelter, as the dividend payouts can be used to rebalance, or to pay tax bills without you having to sell units and trigger capital gains woes if you breach your personal allowance.
Whichever way you go, just remember that any accumulation units in your portfolio are not immune to income tax, and start recording those dividends – just for the fun of seeing what you’re earning, if nothing else.
Take it steady,
- Note the same is true of any income paid by an accumulation unit. But I’m sticking to the term dividends throughout this article for the sake of simplicity. [↩]